Guest Post: The Next Four Years Won't Be As Good As The Last

The people have spoken and President Obama will serve another four years presiding over the United States. Furthermore, there is very little change to the makeup of the House and the Senate, which leaves the Administration in the same battle for control as it was prior to the election. The question now is what will the next four years look like economically?

One thing that has been overlooked on many fronts is that Obama had control of the House and the Senate when he first entered office in 2009. This control lead to the passing of ObamaCare, successive bailout programs for housing, automobiles, and the financial industry which flooded the economy, and financial markets, with dollars - a lot of dollars. Those injections, combined with a massively bombed out economy from the financial crisis, led to a sharp rebound in economic growth which was almost entirely centered around inventory restocking and a resumption of exported goods and services.

However, in 2010, Obama lost control of the House to the Republicans which has led to two subsequent years of political gridlock. That gridlock has resulted in very little progress in providing the fiscal policies necessary to support economic growth.

This lack of progress, which has clouded the planning ability for small businesses, combined with the recession in Europe and slowdown in China, has reduced the need for continued buildup of inventories as the exportation of goods and services has been slowing. The chart below shows the boom in both exports and imports post the recessionary bottom as stimulus impacted the economy and the subsequent fade as economic strength has waned.

Rolling Over The Fiscal Cliff

Unfortunately for Obama he is now facing a "Congress Divided" with John Boehner at the helm swearing to be the first line of defense against further progress of Obama politics and spending programs. This does not bode well for the economy as the "Fiscal Cliff" looms large into the end of year. While it is hoped by many that Congress will work together to provide a short term fix by extending the cuts for another year or so - I would not be too sure about that possibility.

First of all, Obama has made it clear that he will raise taxes on "the rich" and if he gives in to extending the Bush tax cuts again it will not bode well with his constituents. Secondly, it is highly unlikely that the Republican controlled house will just go through with an extension of the cuts for a year as they are committed to reducing the deficit and government spending. Therefore, it is likely that they will be asking for cuts in exchange for changes to the tax code. This impasse, and inability to cooperate, will lead to another "debt ceiling debate" as we saw in 2011 which will ultimately lead to the economy rolling over "the cliff." This is no trivial matter as the economic impact of the increased taxes is roughly 3.5% of GDP in 2013. With the economy barely pushing 1.5% currently a 3.5% clip from that growth puts the economy into a very nasty recession. Of course, at that point, the Administration will start asking for further bailouts and spending programs to once again revive the economy.

What's Another $10 Trillion In Debt

Obama has already laid the foundation for his next four years of Presidency - more green jobs, tackle global warming, raise taxes on the rich and create jobs for the poor. That will come at a hefty price of further government spending. In the first four years of his term Obama increased the Federal Debt by more than 45%, however, with more than $5 Trillion spent in promoting everything from solar panels to housing, the economy only grew by 7.1% during the same time frame (or a total of $905 Billion.) In other words it took more than $5.60 of debt to create $1 of economic growth.

The amount of debt required today to create a single dollars' worth of GDP today is clearly unsustainable. However, the current Administration has been increasing Federal debt at a run rate of more than $1.2 Trillion annually to date. The understanding of the impact of increasing debt on economic growth is crucially important to understand.

As we discussed recently in "Debt and Deficits: Killing Economic Prosperity" it is "the economic impact of spiraling debt levels that have eroded economic growth. Debt is, by its very nature, a cancer on economic growth. As debt levels rise it consumes more capital by diverting it from productive investments into debt service. As debt levels spread through the system it consumes greater amounts of capital until it eventually kills the host. The chart below shows the rise of federal debt and its impact on economic growth."

The current Administration, however, is trapped into the belief that "big government" is the solution to the long term economic ills. However, a simple look at the impact of debt increases on economic growth tells us that this approach is misguided. Regardless, as stated above, further spending increases are going to rapidly run into an antagonistic House of Representatives who will push to block any additional spending programs.

While political gridlock has been a positive for the economy during past Administrations - this cycle is different. Rising debt levels, weak employment, declining wage growth and rising inflationary pressures all act as a retardant to economic growth. Economic growth at sub-2% levels is not strong enough to promote the kind of employment growth needed to absorb increases in the natural working age population which continues to shove an ever larger portion of the population into the masses that have "given up looking for work." In turn this increases the dependency on government support leading to further weakness in consumption and reduced demand which keeps employment weak.

While Bernanke has been flooding the system with monetary policy focused at suppressing interest rates it is fiscal policy from Congress that ultimately begins to clear the way for job creation. However, with the burden of ObamaCare just on the horizon, the threat of rising taxes and increased regulations covering everything from the financial industry to oil and gas - businesses are remaining defensive to protect weakening profitability.

While Obama will continue to increase the Federal Debt to well beyond 100% of GDP - the reality is that economic growth will continue to stall and muddle along at best. At the worst we are potentially facing another recession in the very near future. Either way the economy ahead will remain difficult and disappointing by almost any measure.

The Next Four Years

The next four years in the economy will most likely look a whole lot like the last two. Sluggish growth, lots of political infighting, and continued weak employment as business remain on the defensive.

For investors it will be a continued period of volatility, lower market returns, a falling dollar and continued artificial interventions by the Federal Reserve to suppress interest rates. The Fed's ability to push asset prices has most likely come to an end as prices have been stretched well above underlying valuation metrics particularly as the weakening global economy weighs on revenues and profitability.

Furthermore, the issue of the "fiscal cliff" by the end of the year puts the markets at risk of a sharp correction as positions are sold to lock in capital gains at lower tax rates. Dividend yielding stocks, due to the income chase, are trading at extremely high valuations and are set up for a sharp correction as well.

Lastly, the onset of a recession in 2013, will impact stock prices by at least 30% if not more. That correction will come swiftly and as discussed in "Recession Probability: 100%" it is "...understanding when a recession has begun is hugely important to investors. The table below, which uses monthly S&P 500 data, shows the price declines during recessionary periods going back to 1873. The average drawdown to investor's portfolios is a little more than 30%. During recent recessions the damage has been far worse. "

Overall, the set up going forward looks like it has in the past couple of years. It is unlikely that Obama will move to the center and be more of a politician with the best interest of the economy at heart. It is also just as unlikely that the Republicans will back down and begin to cooperate with the Senate. I could be wrong, of course, and if I am then I will chance my investment posture accordingly. However, the weight of evidence is stacked in favor of "more of the same" which means less for you and me.